Miss de Groot's Revenge

Some thirty-seven years ago when innocence was still in vogue, Adelaide Milton de Groot had a collection of watercolors that was desired by both a world-class Museum and a distinguished Library. Miss de Groot was induced to leave the watercolors to the Museum in her Will. Apparently, she was promised that her watercolors would be held and displayed as a valued part of the Museum's permanent collection. However, when Miss de Groot died, the general public discovered the implacable term "de-accession". Neither the Library nor the Charities Bureau of the New York State Attorney General's Office could do anything to change the result achieved by the exercise of the unfettered business judgment of the Museum. Watercolors by Winslow Homer became, as if by magic, sculpture by David Smith.

In April of this year, however, things may have begun to change. The Internal Revenue Service has privately ruled in a way that may facilitate restrictions on the use that charity may make of donated art works. According to the private letter ruling, such restrictions do not reduce the contribution deduction to less than what the willing buyer - seller would set as fair market value of the works in the absence of restrictions.

PLR 200418002 explains that a husband and wife have been told that a museum would like to be given at the death of the survivor the art works they have collected. Apparently the couple fear that, without an agreement formally imposing use restrictions, the charitable recipient of their collection may not feel obliged to display and hold, whatever representations to the contrary it may have made privately. The couple asked the Service for assurance that use restrictions would not reduce the value of their contribution to the museum to less than its fair market value.

Specifically, the taxpayers would build a gallery to exhibit the art and create a foundation that would share the operation of the gallery with the museum, until the death of the survivor. Title to the collection would pass to the museum at that time. However, title would be subject to defeasance if certain obligations to the integrity of the collection were not observed. That is, under the terms of the gift, a transgression by the museum (such as sending certain works out on extended loan) would shift the title to the foundation.

In this way, the taxpayers intend to protect their collection from a swing in curatorial taste that would either reduce the "wall time" of the art works in their collection or juxtapose inappropriate art works with the result that the "impact" of the articles in their collection would be diminished.

It could have been otherwise.

Congress amended the Internal Revenue Code in 1981 to insert Sec. 2055(e)(4) and Sec. 2522(c)(3). It sought to clarify that a work of art is treated as property separate from the right to exploit the work.

Presumably, Congress found that it was too difficult to reliably determine the value of just the work. It denied a deduction if the copyright is not donated. Should an artist license the copyright for use in a greeting card or poster and then give the work to Museum A, the income tax and gift tax results will differ. For income tax purposes, he will get a contribution deduction for only the cost of his materials. For gift tax purposes, he will have made a taxable gift because he holds the copyright.

If a collector later buys the work from Museum A, only to give it to Museum B, the collector is entitled to a charitable deduction. But his deduction would be limited to the fair market value of what has been given B. The collector never had (and so could not give) that separate property that is the value of the "right to make and sell reproductions of the object". The artist has held on to that right, having plans to exploit it further with a line of cocktail party napkins or lawn ornaments.

The Service might have taken the position in the ruling that imposing use restrictions breaks up the bundle of rights implicit in ownership into separate property, much as Congress said in enacting Sec. 2522, that selling off the copyright unbundles the artist's rights in the work. The Service could have concluded that, if the collector does not surrender to charity all his rights in the property (including a "right to withhold display"), he will have donated less than what a willing buyer would pay to own the work. The Service could have reduced the deduction (or asked Congress to eliminate the deduction, as it did with the donation of the art work without the copyright). If it had taken that position, then contributors, who seek a full deduction, would have to simply trust the Museum and risk that their collection would meet the fate of Miss de Groot's watercolors.

What about "unfettered business judgment"?

Of course, use restrictions may severely circumscribe the business judgment of the museum board and curators. The question posed by the application that led to PLR 200418002 could have been stated: "If the museum were to acquire by purchase the right to exercise unfettered business judgment with respect to the collection, would it have paid more for the collection than the fair market value of the works?" Because the Service has ruled no discount would be required, it must feel that no premium would be paid for the ability to withhold display or sell donated objects.

Does this ruling show some profound change during the last three decades in the relation of collectors, museums and the public? Or is it simply another instance where the Service has questioned whether a discount for the value of art works is appropriate? When asked, Chris Jussel, who is known to the Dunnington firm to be a fine arts advisor, primarily working with estates and with individuals engaged in estate planning, said it was important to remember that from time to time the Service will recognize blockage discounts in the valuation of art works, but it had long resisted the concept.
If a museum has tacked its reputation to the enduring importance of a collection, would it acknowledge a swing in curatorial taste as the public might expect from a dominant cultural institution? Well, that is what the traditional role of the museum requires, says Mr. Jussel.
Only the owner of one of the so-called "blockbuster" collections, who is prepared to give, in addition to the collection, substantial unrestricted funds, could negotiate significant use restrictions. If a museum abandons its traditional independence to acquire a "hot property", are the directors and curators subject to criticism from future generations? When asked, Mr. Jussel said the directors and curators may come to regret the decision long before the public begins to complain about their making it.

Trust vs. Will

Several of our clients have asked whether they should use a Trust Agreement rather than a Will to dispose of property at death. The Will is the traditional document, but we have suggested a Trust be used under the right circumstances.

In a future issue of this Report we intend to offer a detailed comparison. Suffice it to say, the right circumstances are not usually present.

For New York residents, the Trust may be advantageous when the client's family tree cannot be easily proven; provided no testamentary powers of appointment are to be exercised. When health is a concern, a Trust might substitute for a power of attorney during the client's life. If a corporate fiduciary will be used to settle the client's affairs, a trust will allow the client and members of his or her family to become acquainted with the administration and investment officers who will later take charge of matters.

However, a Trust does not save administration expenses (except, apparently, in California) or estate taxes. A trust will not protect the family's privacy in New York, as long as the estate tax here is determined on the basis of a petition in the Surrogate's Court.
Until relatively recently there were subtle differences in the rules and the effect of settling an individual's affairs through a Trust compared to settling an estate by a Will. History, rather than reason, explained those differences. In New York, the differences have largely been eliminated by legislation. In addition, the income tax laws have recently been modified to allow an election to have trust assets and estate assets treated as a single fund. Consequently, the use of Trusts has become more common.

However, the fundamental difference between a Will and a Trust has not changed; namely, the Will is a testamentary instrument that "speaks" at the moment of death with respect to all the client's property whenever acquired, while the Trust is a contract that is limited in its application to property for which the trustee is then the registered owner. If a Trust is used, the client must repeatedly "shovel" to the Trust any asset that has not been acquired with proceeds from a sale of Trust assets. As a hedge against the possibility that the client will not shovel with diligence, a Will should be prepared and signed to function in concert with the Trust.

We would be happy to discuss this matter with anyone who has a question about his or her situation.

Chris Jussel can be reached at cjussel@bestweb.net. This report was prepared with editorial assistance from our summer intern, Laura Dalgliesh.

*****

 

©2004 Dunnington, Bartholow & Miller LLP. All Rights Reserved.